Determining AIG's Next Move

Will the company continue at its recent pace?

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Options volatility in September is in the 150 range. That implies that 68% of trading days in American International Group (AIG) should range under about 10%. As you can see on the chart, it has gone way beyond that on many recent sessions. In fact, Thursday and Friday saw over 20% moves, and if that keeps up, AIG merits an implied volatility in the 300s.

So does that mean you should go run out and by every option in sight here?

Of course not. It's not likely that kind of action continues for any extended stretch. And if AIG sits still, the daily decay and volatility risk of owning 150 volatility is rather large. I mean the September 50 straddle trades at something like $14. With under three full weeks of trading to go, that's a lot of wood to make up if you buy it, and AIG stops moving around at this pace.

What I'd say, though, is that this is exactly why many options traders preach that triple-digit volatility is a buy. Options volatility is only relevant in comparison to the volatility of the underlying. No one knows the volatility of the underlying going forward, so the best clue around (barring an expected news event) is the volatility of the recent past. And given AIG's recent past, hard to say straight shorting options here and closing your eyes makes any sense.

That being said, bubbly stocks have what seems like backwards volatility behavior. The more AIG rallies, the higher volatility will likely climb. Conversely, if AIG drifts down a bit, volatility likely contracts. And that's part of why I like the idea of owning options paper at strikes near here, and shorting it on the wings. Although ironically, I suspect the higher "wing" will come back to haunt me.The implosion of AIG has the world up in arms. Join Hoofy & Boo as they take you through what happened, from start to finish.

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